Canadian Tax Court Upholds Assessment of Discounted Receivables Sale in McKesson Canada Corp.

On December 13, 2013, the Tax Court of Canada rejected McKesson Canada Corp.’s appeal of a CAD 26.6M transfer pricing reassessment related to the sale of accounts receivable to its foreign parent. The courts found the transaction at issue was more of a tax avoidance plan than a structured finance product (1).

Luxembourg-based McKesson International Holdings III S.a.r.l , a subsidiary of U.S.-based McKesson Corp., and the immediate parent of McKesson Canada, acquired the receivables at a discount rate of 2.206%. Justice Patrick Boyle agreed with the CRA that the rate was excessive and should not have exceeded 1.0127%. The judge went on to state that the appropriate range for the overall discount provided by McKesson was 0.959% to 1.17% and the rate on which the CRA based its reassessment under Section 247(2)(a) and (c) of Canada’s Income Tax Act was appropriate for an arm’s length transaction.

The McKesson ruling represents a big win for the CRA and Canada’s Department of Justice, and serves as a warning to taxpayers against factoring their receivables with related parties. The expert testimony could not change the impression that McKesson Canada lacked a business purpose for factoring receivables, this transaction reduced profits and created losses and the primary purpose was to obtain a tax benefit.

Agreement Between Parties
McKesson Canada is the principal Canadian operating entity in the international group of companies owned by McKesson Corp. The group’s core business is the wholesale distribution of over-the-counter and prescription pharmaceuticals. In 2002, according to the tax court ruling, McKesson Canada entered into a contract with McKesson International Holdings, its Luxembourg parent, under which it sold receivables to its affiliate on a daily basis, at a discount from the face amounts.

At the time the receivables purchase agreement was made, McKesson Canada had sales of CAD 3.0B and profits of CAD 40.0M, credit arrangements with major financial institutions in the hundreds of millions of dollars and a sizeable credit department that collected the receivables within 30 days (on average) and a bad debt experience of only 0.043%. There was no evidence of pending imminent or future change in the makeup, nature or quality of McKesson Canada’s receivables or customers. At the time, McKesson Canada had no identified business need for a cash infusion or borrowing, nor did McKesson Group need its Canadian subsidiary to raise funds for another member of the group.

Most of the proceeds of the initial CAD 460M receivables sale were returned by McKesson Canada to its non-resident shareholder affiliate, while a portion was loaned for some time to another Canadian corporation to permit its tax losses to be used. About 1% of the proceeds were used by McKesson Canada for its general corporate purposes. As a direct result of the 2.206% discount provided by McKesson Canada to its affiliate, McKesson Canada ceased to be profitable for its 2003 tax year and reported a tax loss during the tax year at issue. The company’s profits in subsequent tax years were significantly reduced as well.

Implications of the Ruling
The ruling confirms the Supreme Court of Canada’s view in the precedent-setting Canada v. GlaxoSmithKline Inc. that the transfer pricing guidelines of the Organisation for Economic Co-operation and Development do not represent law, per se, in Canada. According to Glaxo, the court is to take into account all the transactions, characteristics and circumstances that are relevant – including economically relevant – in determining whether the transactions at issue are at arm’s length.

Conclusion
The receivables transaction undertaken by McKesson Canada was clearly not a securitization transaction, nor was there any apparent financial or business reason for McKesson Canada to be interested in a securitization transaction. The purpose was to reduce McKesson Canada’s Canadian tax liability (and therefore McKesson Group’s worldwide tax liability) by paying the maximum discount under the agreement that McKesson Group believed it could reasonably justify. For the McKesson Group, this appears to have been much more of a tax avoidance plan than a structured finance product.
The primary reasonable and predominant purposes of non-arm’s-length transactions are a relevant factor, and the maximum amount deductible in Canada by McKesson Canada is limited to what an arm’s length person would agree to pay for the rights and benefits obtained. The judge was not impressed by the fact that the role of McKesson Canada’s credit department was essentially unchanged before and after the transaction and it did not help that the Luxembourg parent had only one employee.

On January 10, 2014, McKesson Canada filed a notice to appeal the Tax Court’s ruling before the Federal Court of Appeal. Currently, no date has been set for the appeal to be heard.

(1) Refer to McKesson Canada Corp. v. The Queen, Tax Court of Canada, Nos. 2088-2949 (IT)G, 12/13/31 for more information.